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Why Is It Hard for China and the U.S. to Cut a Deal on Trade?

Updated: Aug 9, 2018

Authors: Cheng Li, Director, Brookings Institution; Diana Liang, Research Assistant at the Brookings Institution

Trade tension between the United States and China is not a new phenomenon. Since China’s ascension to the World Trade Organization (WTO) in 2001, the two countries have brought as many as 35 disputes against each other. Yet, the recent series of events is different and threatens to be escalatory and prolonged. Since the U.S. imposed trade sanctions on China four months ago — stemming from a Section 301 investigation — many have begun referring to this current spat as a “trade war.”

The factors that have prevented both sides from cutting a deal are not limited to the economic domain. Unless we assess the political and security issues playing out on the sidelines, we will not fully grasp the nature, current deadlock, and possible trajectory of the ongoing confrontation between the two largest economies in the world. Three factors are crucial to understanding the current stasis.

Serious political considerations limit China’s options

Although a trade war would hurt both countries, the country with the trade surplus is usually hit harder and thus is more likely to be driven to compromise. This was true of Japan in the 1980s, for instance. But only the first half of this equation is likely to be true for China. China has already begun feeling the pain and can expect more. The trade war not only affects key engines of China’s economic development, including the Greater Bay Area, the Yangtze River Delta, and the Beijing-Tianjin-Hebei Corridor, but also has broad implications for all economic sectors because of the country’s reliance on foreign trade. Stock markets have reacted negatively to the trade spat, with Shanghai entering bear market territory and Hong Kong dropping to a ten-month low. Further fallout could throw off the government’s delicate balancing act by leading to increased capital outflows and accelerating problems in the country’s shadow banking industry and its local debt management. Extended trade confrontation could also affect Chinese property prices — a tremendously sensitive issue for the Chinese public.

By contrast, the U.S. has a relatively strong and stable economy. To maximize pressure, China’s retaliatory trade actions have focused on specific industries and geographical regions in the United States. The largest share of tariffs is assigned to agricultural and food products (38%), thus heavily concentrating on counties that voted for Trump. However, because the U.S. imports far more from China than vice versa, China’s ability to inflict pain through tariffs alone is limited.

Such costs to the Chinese economy — especially if they leak into the property sector — will place great political pressure on the Chinese leadership. President Xi Jinping will be harshly judged for how he handles this trade war, and any major missteps could prompt a political crisis. Under the dire circumstances, the Chinese leadership will likely search for a solution other than compromise on the trade front. Chinese media has diffused some of the pressure by attributing U.S. actions to a “crazy” and “greedy” President Trump, buying some time for Xi’s preferred tactic — negotiation. Also, to the benefit of the Chinese leadership, the Chinese public has come to view escalatory U.S. trade actions as part of a “conspiracy” to undermine China’s rise. However, continued escalation by the U.S. and the resulting political pressure in China may limit Xi’s options. Lest Chinese leaders be seen as capitulating to U.S. demands, rising domestic political pressure may leave them with no choice but to stand firm.

Improved relations between Beijing and Pyongyang diminish Trump’s bargaining chips

President Trump favors highly transactional exchanges, in which trade, security, and political issues are interlinked bargaining chips. He has demonstrated this in the past by walking back on claims that China is a currency manipulator in exchange for cooperation with Beijing over North Korea, thus compromising on the economic front in pursuit of a security interest.

However, relations between Beijing and Pyongyang have improved dramatically, so Trump’s pool of bargaining chips has shrunk. In the lead-up to and immediately following the Singapore summit, Kim Jong-un made three high-profile visits to China, despite making none in the seven years prior. China had been willing to coordinate with the U.S. on North Korea to avert a crisis on the Korean Peninsula (exacerbated by the exchanges between Trump and Kim in the media), especially amid the Chinese leadership’s simmering frustration over Kim’s relentless missile testing, the execution of his pro China uncle, and alleged assassination of his half-brother who was under Beijing’s protection. With the patching-up of Beijing-Pyongyang relations, China will be less accommodating of U.S. demands for continued maximum pressure on North Korea.

U.S.-China relations have also changed in important ways in the past few months. Trump’s 2018 State of the Union Address named China—alongside terrorist groups, rogue states, and Russia—as a rival. Both the National Security Strategy and the National Defense Strategy characterized relations with China as a strategic rivalry. This kind of language is deeply alarming to China. Furthermore, Beijing’s concerns in the security realm have been augmented by U.S. actions related to Taiwan, including the passage of the Taiwan Travel Act and plans for a U.S. Navy port visit. This environment of mistrust will drive Chinese leaders to treat any new deals offered by Trump with suspicion. The domestic political environments in both countries make it difficult for either side to reach a deal.

A hawkish policy team and hesitant business leaders in the U.S.

Trump’s current team may also complicate efforts to bring both sides to the negotiating table. From the Chinese perspective, the departure of Gary Cohn and the marginalization of Jared Kushner have left few members of the Trump team who have positive working relationships with China. The officials who remain, such as Robert Lighthizer, Peter Navarro, and John Bolton, are hawkish on China, and Navarro and Bolton are well known for their pro-Taiwan views. These sceptics of China will not offer much margin for negotiation or compromise.

Nor can China hope to make its case through U.S. business leaders, who are less willing than before to talk Trump down or bring the two sides together. Though American companies have complained about the costs of current trade measures and oppose a trade war, they are nevertheless disturbed by Chinese industrial policy, the incorporation of party branches into joint ventures, the new national security law, and other negative trends in China’s “state capitalist” system. These concerns are compounded by frustration over years of undelivered promises to open up. China, therefore, has few friends in the U.S. and must try to reduce tensions while muddling through the rotating cast of actors that comprise Trump’s team.

The bigger picture

These security and political conditions make the environment for negotiation and compromise difficult. Of course, we cannot rule out the possibility that either side will dramatically change its position and push for a resolution. Trump himself has been known to turn on a dime. China could find unconventional solutions by exploiting Trump’s views on economic, political, and security issues as interlinked bargaining points. At the same time, however, these political and security pressures could constrain the leaders and pressure them to stay the course or even escalate tensions.

These obstacles should urge us to look at the bigger picture. These security and political factors should demonstrate the seriousness and urgency of our current predicament. Not only does a trade war hold disastrous consequences for both countries, but it elevates the risk of an actual war. Such a hot war would be unimaginable and globally destabilizing.

It is precisely because of these consequences that we must address the obstacles that prevent us from reaching a resolution. Perhaps it is this risk — of escalation from a trade war to a real war — that can bring the two sides to the table. We must return to engagement on the most important, shared security concerns and to recognizing the complementary nature of both economies. It is only in doing so that we can prevent a vicious zero-sum competition, which will in fact yield no winners at all.

Photo Credit: Xinhua

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